This article is excerpted from Tom Yeung’s Profit & Protection newsletter dated Aug. 16, 2022. To make sure you don’t miss any of Tom’s picks, subscribe to his mailing list here.
When I recommended shares of CRISPR Therapeutics (NASDAQ:CRSP) and Beam Therapeutics (NASDAQ:BEAM) in July, biotech’s future seemed dim at best. Fed Chairman Jerome Powell had just raised rates by 75 basis points the month before, and the age of easy money seemed to be long gone. Shares of CRISPR and Beam had both fallen two-thirds from their peak.
These top Cathie Wood holdings — along with Ginkgo Bioworks (NYSE:DNA) — are the stock market’s canaries in the coalmine. Because profits of these biotech firms are many years into the future, analysts must “discount” those earnings a longer way back to the present.
To borrow a term from the fixed income world, these Cathie Wood picks are “long duration” stocks.
For equity investors, these long-duration stocks matter. That’s because these companies are some of the earliest-warning signals in the ARK Invest portfolio – shares of BEAM peaked in July 2021, around five months before the Nasdaq hit its all-time high. And all three bottomed out in May, a month earlier than the Nasdaq index’s trough. It’s one of the closest thing that equity investors have to a crystal ball.
Today, these stocks are telling a new story. Since I recommended the stocks, shares of CRISPR have stabilized in the $70-$80 range, while Beam has risen 33%. Even Ginkgo Bioworks — a moonshot bet that loses $3.50 for every dollar generated – has rebounded into the mid-$3 range. The company now scores an A+ for its Profit & Protection momentum score.
Two More of Cathie Wood’s Canaries
Two other Cathie Wood stocks are also pointing to a return of better times.
- DraftKings (NASDAQ:DKNG). The online sports betting platform peaked in March 2021, nine months before the Nasdaq top. The 70% recovery of this consumer discretionary stock points to a a greater willingness by investors to take leaps of faith.
- Zoom Video (NASDAQ:ZM). Cathie Wood’s No. 2 holding peaked over a year before the Nasdaq did. Shares have stabilized since March.
These stocks represent early peaking companies. DraftKings is one of Cathie Wood’s few consumer discretionary stocks – a sector that typically outperforms in early stage recessions, according to research from Fidelity Investments. And Zoom was an early beneficiary of the work-from-home movement that fell after the initial rush subsided.
And in each of these cases, shares of early peaking stocks have stopped falling for at least three months.
That’s essential. The Profit & Protection system finds that momentum effects start to take hold around the three-month mark (and peaks at the 12-month one). Over the past decade, investors buying shares in the quintile of top-performing stocks from the past-three months can outperform by a small margin.
In other words, the early warning stocks of Cathie Wood’s ARK Invest are now suggesting the road to recover has finally begun.
1 Cathie Wood Stock Warning About More Losses to Come
Yet, not every Cathie Wood stock is signaling that the depths of investor despair have passed. And one in particular is still warning of more potential drawdowns.
That stock is ARK Invests’ No. 1 holding:
Shares of the electric vehicle firm have defied gravity, just as how its CEO has defied security and safety regulators. TSLA shares trade only a quarter off their all-time high, despite mounting concerns over its shoot-now-ask-questions-later strategy.
“Investors might believe there is some risk from Tesla’s aggressive approach to FSD development,” Al Root of Barron’s noted, “But for now, they’re focused more on sales growth and margins.”
These are major causes for concern. In cases such as Cathie Wood’s biotech picks, these shares needed to come crashing to earth before becoming attractive to the Profit & Protection stock selection system. Only when markets have fully given up is it time to start picking up the scraps.
Meanwhile, Tesla’s valuation has remained elevated. Shares trade for 70x forward earnings and are worth more than the next 14 automakers combined. On a price/sales basis, it’s more expensive than tech firms like Apple (NASDAQ:AAPL) and Microsoft (NASDAQ:MSFT), firms with a far better return on capital invested profile. By my estimate, shares could fall 50% and still look pricey.
What Cathie Wood’s ARK Invest Is Saying to Do Next
There’s nothing new to the stock market’s many personalities.
Energy stocks… Gold… Commodities…
These alternative investments have always provided some measure of diversification.
But sometimes, the market throws a wrench into the works. Shares of GameStop (NYSE:GME) and AMC Entertainment (NYSE:AMC) rose to unbelievable levels in 2021 after meme stock traders jumped in.
And just as companies can overshoot their valuations, they can also undershoot on the way down. Shares of Desktop Metal (NYSE:DM) and RealReal (NASDAQ:REAL) remain top Profit & Protection picks for their rock-bottom prices.
Today, many of Cathie Wood’s “long-duration” picks are suggesting that the worst of the bear market is finally behind us; investors should expect a long, slow climb as the Fed starts relaxing monetary policy in 2023.
But investors shouldn’t rush out and buy everything all at once. The Nasdaq Index rebounded 32% in Q4 2001, only to drop another 32% again the following year. And as Tesla’s elevated valuation tells us, the price of highly valued stocks can still fall right back down.
Tom Yeung is the editor of Profit & Protection, a free e-letter about investing to profit in good times and protecting gains during the bad. To join Profit & Protection — and claim a free copy of Tom’s latest report — go here to sign up for free!